The conversion to International Financial Reporting Standards, coupled with the movement towards fair value accounting and Congress' need for revenue, could result in the repeal of the last-in/first-out, or LIFO, method of inventory accounting.
"It's a perfect storm for LIFO repeal," said Tom Ochsenschlager, vice president of taxation at the American Institute of CPAs. "LIFO is walking around with a target on its back, so prospects are high that it will be repealed. Even though the revenue would be the same if it came from the adoption of IFRS or congressional repeal, Congress would not get credit in their pay-for unless they initiate it legislatively, so the pressure is on Congress to do it."
The repeal of LIFO would have a substantial impact, according to Michelle Koroghlanian, technical manager at the AICPA. "Companies have been using it since as far back as the 1930s," she explained. "It's not just something that affects oil and gas. For example, it is widely used across industries like manufacturers, auto parts and auto dealers. It's used in every industry, including retailers, that has inventory and in which prices are not falling."
Many small family-owned and privately held businesses also use the threatened inventory accounting method, Koroghlanian pointed out. "In fact, for smaller companies the use of LIFO helps to finance their operations," she said. "It allows them to defer payment and have the use of cash today that they wouldn't otherwise have. By having that cash, they don't have to finance from outside so much. Smaller companies will be harder hit because they've been less likely to get outside financing the last few years."
At the moment, LIFO is not a part of any revenue offsets, noted Leslie J. Schneider, a partner at the Washington law office of Ivins, Phillips & Barker, who serves of counsel to the LIFO Coalition, a group of more than 115 trade associations that oppose proposals by the U.S. Congress to repeal or restrict the use of LIFO.
"The danger is in both the Presidential Advisory Board proposals on tax reform which will come out in December, and [House Ways and Means Committee Chairman Charles] Rangel's proposal to take up corporate tax reform next year," Schneider said. "The expectation is that repeal of LIFO is one of the items they will consider, since it was in Rangel's 'Mother of All Tax Bills' in 2007."
The proposed repeal of LIFO would have a devastating effect on companies, said Schneider. "The proposals would require companies to pay back taxes on LIFO reserves over an eight-to-10-year-period. This would be huge relative to a company's taxable income, like five or 10 times the average income for a year. It would require a staggering amount of capital theoretically tied up in inventory, and a lot of smaller companies would go out of business."
THE SPARK THAT SET THE FIRE
The origins of the current debate on LIFO stem from the confluence of high gas prices, animosity toward oil companies and windfall profits, and growing recognition on the part of Republicans that they were in trouble in the 2006 elections, according to Christian Klein, vice president of public affairs for Associated Equipment Distributors.
"The Republicans proposed LIFO repeal as a way to pay for a gas tax rebate," said Klein. "It was an election-year gimmick. The perception was that LIFO was used by oil companies to mitigate the impact of inflation on inventory, so they decided it was a good way to score political points against them. But they didn't understand that LIFO is also used by small businesses, not just the big faceless oil companies."
Eventually, the measure died, recalled Klein. "But once a bad idea is out of the bottle, it's hard to get it back in."
"The idea of targeting LIFO came back in 2007 in Rangel's comprehensive tax overhaul bill," he said. "And it popped up again in the Obama budget, but was not in either the House or Senate budget resolutions."
"It's not safe," said Jade West, senior vice president of government relations for the National Association of Wholesale Dealers. "Once a revenue offset gets onto the radar screen, it never goes away. If it dodges the efforts to pay for extending current tax breaks, it will be back on the menu next year."
IF LIFO DOESN'T LAST
The true impact of LIFO repeal on a company's fortunes is proprietary information that most companies are not keen on divulging, said West.
"However, the tax executive of a large corporation told me that the company would go from paying $200 million to $400 million a year in tax. They would survive, because they can," she said. "But a small business with a $6 million LIFO reserve would owe $2 million per year, which is more than the net worth of the company. They would have to borrow to pay the tax, but it's unlikely they could find a willing lender. The owner said he would go out of business."
"It couldn't come at a worse time for the economy," said Ochsenschlager, who stated that the AICPA doesn't have an official position on the matter. "A car dealer with an $8 million reserve could be picking up a million in taxable income even if he only sold one car under the Rangel proposal."
Of course, a strict convergence between generally accepted accounting principles and IFRS would have the effect of repealing LIFO, West said. "That is because the Tax Code, in Section 472(c), requires a taxpayer that uses LIFO for tax purposes to also use it for financial reporting."
"That was one of the initial catalysts," said AED's Klein. "The thought was, 'They'll get rid of it anyway, so we might as well get all the money now.'"
